Which alternative is best (time value of money)?

Jane is a finance major at a university and has a $600 overdue debt for books and supplies at the bookstore. She has only $200 in her checking account and doesn't want her father to know about this debt. The manager at the bookstore tells her that she may settle the account in one of two ways since she cannot pay it all now.

Option 1: Pay $200 now and $450 when she completes her degree, two years from today.

Option 2: Pay $800 one year after completion of her undergraduate degree program, three years from today.

Assuming that the cost of money is the only factor in Jane's decision and that the cost of money is 8%, which alternative should she choose? Why? Support you answer with computations and label all items in you analysis.

Solution Preview

For both options, we compute the Present Value (PV) using the given cost of ...